Savers in for $250m tax gain

By BRIAN FALLOW AND ELLEN READ

Savers could be about $250 million a year better off under sweeping changes to the tax treatment of investment income foreshadowed yesterday.

Finance Minister Michael Cullen indicated broad support for most of the recommendations of independent adviser Craig Stobo.

Stobo's job was to see if a consensus could be found for cleaning up an area of tax law known for distortions and inconsistencies.

Cullen said no decisions had been made as yet.

The Government's position would be spelled out in next year's Budget because of the significant cost in lost revenue - a rough estimate was $250 million a year.

But Cullen is on record as supporting scrapping the capital gains tax on share trading profits made by managed funds used by superannuation schemes.

That would align their tax treatment with passive funds and shares held directly.

Stobo found such a change had majority support in the industry.

Cullen said he would be surprised if the final package did not include some provision to "look through" investment vehicles and tax the earnings on a person's savings at the same rate as their other income.

Savers on the 19.5 per cent marginal tax rate have a reason not to save through superannuation schemes and unit trusts, because the income is taxed at 33c in the dollar.

The proposed change would reproduce what happens with interest on bank deposits, where banks deduct tax at the saver's marginal rate and pass it to Inland Revenue.

The most vexed area of the existing system is the treatment of overseas portfolio investments, a nightmare of complexity and inconsistency.

Stobo recommends scrapping the existing rules and adopting an "investment and savings tax" (IST), a generic term covering variants of the risk-free return method recommended by the McLeod tax review.

The investments are valued at the start of the year and taxed on an assumed rate of return, regardless of how they perform.

"The tricky thing about an IST is you get taxed even when you make a loss," Cullen said.

"But you also get taxed a lot less when you make a decent gain.

"From an economic perspective you would be wise to opt for an IST if the rate is set right because over the life of a scheme you would expect to do better, as it is a risk-free return versus a rate of return which incorporates a level of risk."

Cullen said he "leaned towards" the system for overseas investments because no one had suggested a better way of simplifying the system.

Stobo preferred extending the IST system to domestic savings as well, on consistency and theoretical grounds.

But he conceded that Cullen's preferred option of dealing with domestic anomalies by dropping the capital gains tax was closer to what the market wanted.

Cullen said it was likely to be April 1, 2007, before the new system came into effect.

National's finance spokesman, John Key, favoured scrapping capital gains tax and having a look-through system.

"And I think the risk-free return method is probably the way to go with overseas investments."

But it would look too much like a wealth tax if applied domestically.

PricewaterhouseCoopers partner John Shewan welcomed the clarity and promptness of Cullen's response to Stobo's recommendations.

But he said some investors would be worse off, notably those who invested in the grey list countries - Australia, Britain, the United States, Canada, Japan, Germany and Norway - and faced tax only on their dividends, commonly less than 6 per cent.

But it was hard to justify dividing the world into approved and penalised investment destinations.

Investment Savings and Insurance Association chief executive Vance Arkinstall said: "We are particularly pleased at the way in which Stobo has been able to gather consensus, especially for the 'look-through' regime and the need for the removal of tax on capital gains.

"Those two are hugely important for this industry and are distortions we've long argued have to be removed."

NZX chief executive Mark Weldon said the report heralded a major change in the treatment of investment income that could only be good for the economy.

The differences

The main changes likely are:

Scrapping the capital gains tax for managed funds.

Taxing the income a saver's money earns while in a fund manager's hands at the saver's own tax rate.

A wealth tax on overseas portfolio involvements.

Tax policy